Wednesday, March 6, 2013

The following is a guest post by Tsachy Mishal of TAM Capital Management who presents the bull case on Crimson Wine Group (CWGL) which was recently spun-off from Leucadia National (LUK). Tsachy also runs the blog, Capital Observer.

Crimson Wine Group: A Unique Spin-off Opportunity

Crimson Wine Group (CWGL) is a unique spin-off opportunity. Crimson Wine was separated from Leucadia National Corp (LUK) prior to its acquisition of Jefferies. The stated reason for the spin-off is as follows:

“Jefferies has advised Leucadia that Jefferies’ management deemed Crimson as less strategically relevant than Leucadia’s other subsidiaries, ascribing a value to Crimson no greater than approximately its book carrying value. As such, in assessing and negotiating the terms of the transaction with Leucadia, Jefferies’ management advised Leucadia that Jefferies viewed the pre-transaction divestiture of Crimson through the Leucadia winery business separation an efficient and desirable method of divesting Crimson, as compared with a post-transaction sale or other divestiture. It was therefore agreed between Jefferies and Leucadia that that the separation occur prior to consummation of the transactions, without reducing the book value of Leucadia by more than $197 million and that it be effected without Leucadia retaining any material liability with respect to Crimson.”

My interpretation of this is that there was a disagreement about the value of Crimson between Jefferies and Leucadia. Jefferies did not believe Crimson was worth more than stated book. That would imply that Leucadia management believed it was worth more than stated book value since they decided to spin this off. If Leucadia management were willing to accept stated book as the valuation than there would be no reason for the spin.

Leucadia management owns a significant portion of the company with Chairman Ian Cummins owning 8.7% of the shares and Joseph Steinberg owning 9.7% of the shares. I believe it is significant that they felt it important to carve out this asset rather than to allow it to be valued at book value. This is especially important because this asset only makes up about 2% of the combined company. If it were worth anywhere close to stated book it would hardly be worth it to spin this off.

It is also worth noting that Leucadia management is in a much better position to value these assets as they have owned some of them for over twenty years. The Jefferies position is understandable in the context of a large financial company. Pro forma for the deal, Crimson would represent approximately 2% of book value. Financial companies are generally valued based on book value. It is unlikely given how small Crimson is relative to Leucadia that the market would ascribe value above book. So even though Leucadia thought it was worth much more than book, Jefferies thought they would never get credit for it in a large financial company.

Valuation

There are two ways to tackle the valuation of Crimson. The first is by book value and the second is through earnings power. I will attempt to do both starting with book value. Below is the pro forma balance sheet given by Crimson. Stated book value is $7.82:

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ASSETS

Current assets:

Cash and cash equivalents

21,329

Accounts receivable, net

5,287

Inventory

41,487

Other current assets

663

Total
current assets

68,766

Property and equipment, net

108,485

Goodwill

1,053

Other intangible assets, net

20,403

Total

198,707

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LIABILITIES

Current liabilities:

Accounts payable

857

Accrued expenses

5,393

Customer deposits

1,178

Total
current liabilities

7428

Total
liabilities

7428

EQUITY

Common shares, par value $1 and $.01 per share

245

Additional paid-in capital

277,176

Retained deficit

-86,142

Total
equity

191,279

Total

198,707

Breakdown of Wineries

Crimson Wine Group is in the winery business and owns several vineyards. Crimson lists the value of its property and equipment on its balance sheet as $108,485, which includes the vineyards it has acquired. Crimson has acquired its vineyards over twenty plus years. The land is listed at cost even though the price has appreciated materially. Below is a breakdown of the value of their vineyards:

Pine Ridge Archery Summit - Pine Ridge and Archery Summit are Crimson Wine Groups most valuable wineries. Pine Ridge Vineyards was acquired in 1991 and has been conducting operations since 1978, Archery Summit was started in 1993. In 2001 they were put on the market by Leucadia for $150 million as seen in this Wine Spectator article. Napa Valley winery prices trade at record prices and at significantly higher prices today than they did in 2001. I believe that this property is worth at least $150 million.

Seghesio Family Vineyards- Seghesio was acquired for $86 million in May 2011.

Chamisal Vineyards- Chamisal acquired for $19.2 million in August 2008.

Double Canyon- Crimson acquired 611 acres in Horse Heaven Hills, Washington for an undisclosed price in 2005 and 2006. A conservative estimate of their land and equipment there is $10,000,000.

The table below summarizes the value of Crimson’s wineries:

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Winery

Value

Pine Ridge Archery Summit

$150,000,000

Seghesio Family Vineyards

$86,000,000

Chamisal Vineyards

$19,200,000

Double Canyon

$10,000,000

Total

$265,200,000

By assigning a value of $265 million to Crimson’s property & equipment and zero value to its intangible assets the book value becomes $326.3 million or $13.34 cents a share.

By looking at Crimson’s past earnings it is difficult to justify the current price. For the first nine months of 2012 Crimson reported 19 cents of pro forma earnings. However, the future outlook is brighter as earnings are set to ramp up.

Crimson has been significantly increasing production in recent years. Between 2009 and 2012 it increased production from 117,000 cases to 296,000 cases. At the same time gross margins have increased from 23% to 52%. This increase has followed production increases in a relatively straight line as Crimson moves to much higher levels of capacity utilization. Revenue per case has been between $185 and $235. After bottoming in 2011 at 185, revenue per case increased again in 2012 as a result of greater contribution from Seghesio which has a higher than average ASP. During the same period opex has consistently grown slower than sales.

The Form 10 discloses that in 2013 they will be able to increase production by 58,000 cases at Chamisal and 50,000 at Seghesio. This leads to total production of 404,000. Assuming revenue per case of $195 and a slower than historical ramp in gross margins to 55%, this leads to net income of nearly $17 million. Net income is equal to EBIT because they have no debt and NOLs shield them from cash taxes. Cash flow will generally be better than net income as maintenance capex is half of D&A.

I estimate that Crimson will earn 70 cents in EPS in 2013 and roughly 79 cents in free cash flow per share. There are two pure play wine companies, Treasury Wine and Concho y Toro. They trade at an average of 20 times 2013 earnings estimates and 14.5 times FCF. Based on these valuations CWGL would be worth $14 on an EPS basis and $12.25 on an FCF basis (once one adds back $22.3 million in net cash). That works out to an average of $13.13, not far from my $13.34 estimate of tangible book value. It is important to remember that CWGL is under earning because its capacity utilization is low.

Conclusion

Crimson Wine Group has all the ingredients of a successful spin-off. The company has savvy management with a large ownership interest, the stock is too small for institutions to hold and there is no sell side following. From the current price of $7.78 the stock has roughly 70% upside to a conservative valuation.

The author is long shares of CWGL. Under no circumstances does this constitute investment advice. Under no circumstances does this information represent a recommendation to buy, sell or hold any security. The information is for educational purposes only. Positions may change at any time without notice.

The following is a guest post by Tsachy Mishal of TAM Capital Management who presents the bull case on Crimson Wine Group (CWGL) which was recently spun-off from Leucadia National (LUK). Tsachy also runs the blog, Capital Observer.

Crimson Wine Group: A Unique Spin-off Opportunity

Crimson Wine Group (CWGL) is a unique spin-off opportunity. Crimson Wine was separated from Leucadia National Corp (LUK) prior to its acquisition of Jefferies. The stated reason for the spin-off is as follows:

“Jefferies has advised Leucadia that Jefferies’ management deemed Crimson as less strategically relevant than Leucadia’s other subsidiaries, ascribing a value to Crimson no greater than approximately its book carrying value. As such, in assessing and negotiating the terms of the transaction with Leucadia, Jefferies’ management advised Leucadia that Jefferies viewed the pre-transaction divestiture of Crimson through the Leucadia winery business separation an efficient and desirable method of divesting Crimson, as compared with a post-transaction sale or other divestiture. It was therefore agreed between Jefferies and Leucadia that that the separation occur prior to consummation of the transactions, without reducing the book value of Leucadia by more than $197 million and that it be effected without Leucadia retaining any material liability with respect to Crimson.”

My interpretation of this is that there was a disagreement about the value of Crimson between Jefferies and Leucadia. Jefferies did not believe Crimson was worth more than stated book. That would imply that Leucadia management believed it was worth more than stated book value since they decided to spin this off. If Leucadia management were willing to accept stated book as the valuation than there would be no reason for the spin.

Leucadia management owns a significant portion of the company with Chairman Ian Cummins owning 8.7% of the shares and Joseph Steinberg owning 9.7% of the shares. I believe it is significant that they felt it important to carve out this asset rather than to allow it to be valued at book value. This is especially important because this asset only makes up about 2% of the combined company. If it were worth anywhere close to stated book it would hardly be worth it to spin this off.

It is also worth noting that Leucadia management is in a much better position to value these assets as they have owned some of them for over twenty years. The Jefferies position is understandable in the context of a large financial company. Pro forma for the deal, Crimson would represent approximately 2% of book value. Financial companies are generally valued based on book value. It is unlikely given how small Crimson is relative to Leucadia that the market would ascribe value above book. So even though Leucadia thought it was worth much more than book, Jefferies thought they would never get credit for it in a large financial company.

Valuation

There are two ways to tackle the valuation of Crimson. The first is by book value and the second is through earnings power. I will attempt to do both starting with book value. Below is the pro forma balance sheet given by Crimson. Stated book value is $7.82:

-->

ASSETS

Current assets:

Cash and cash equivalents

21,329

Accounts receivable, net

5,287

Inventory

41,487

Other current assets

663

Total
current assets

68,766

Property and equipment, net

108,485

Goodwill

1,053

Other intangible assets, net

20,403

Total

198,707

-->

LIABILITIES

Current liabilities:

Accounts payable

857

Accrued expenses

5,393

Customer deposits

1,178

Total
current liabilities

7428

Total
liabilities

7428

EQUITY

Common shares, par value $1 and $.01 per share

245

Additional paid-in capital

277,176

Retained deficit

-86,142

Total
equity

191,279

Total

198,707

Breakdown of Wineries

Crimson Wine Group is in the winery business and owns several vineyards. Crimson lists the value of its property and equipment on its balance sheet as $108,485, which includes the vineyards it has acquired. Crimson has acquired its vineyards over twenty plus years. The land is listed at cost even though the price has appreciated materially. Below is a breakdown of the value of their vineyards:

Pine Ridge Archery Summit - Pine Ridge and Archery Summit are Crimson Wine Groups most valuable wineries. Pine Ridge Vineyards was acquired in 1991 and has been conducting operations since 1978, Archery Summit was started in 1993. In 2001 they were put on the market by Leucadia for $150 million as seen in this Wine Spectator article. Napa Valley winery prices trade at record prices and at significantly higher prices today than they did in 2001. I believe that this property is worth at least $150 million.

Seghesio Family Vineyards- Seghesio was acquired for $86 million in May 2011.

Chamisal Vineyards- Chamisal acquired for $19.2 million in August 2008.

Double Canyon- Crimson acquired 611 acres in Horse Heaven Hills, Washington for an undisclosed price in 2005 and 2006. A conservative estimate of their land and equipment there is $10,000,000.

The table below summarizes the value of Crimson’s wineries:

-->

Winery

Value

Pine Ridge Archery Summit

$150,000,000

Seghesio Family Vineyards

$86,000,000

Chamisal Vineyards

$19,200,000

Double Canyon

$10,000,000

Total

$265,200,000

By assigning a value of $265 million to Crimson’s property & equipment and zero value to its intangible assets the book value becomes $326.3 million or $13.34 cents a share.

By looking at Crimson’s past earnings it is difficult to justify the current price. For the first nine months of 2012 Crimson reported 19 cents of pro forma earnings. However, the future outlook is brighter as earnings are set to ramp up.

Crimson has been significantly increasing production in recent years. Between 2009 and 2012 it increased production from 117,000 cases to 296,000 cases. At the same time gross margins have increased from 23% to 52%. This increase has followed production increases in a relatively straight line as Crimson moves to much higher levels of capacity utilization. Revenue per case has been between $185 and $235. After bottoming in 2011 at 185, revenue per case increased again in 2012 as a result of greater contribution from Seghesio which has a higher than average ASP. During the same period opex has consistently grown slower than sales.

The Form 10 discloses that in 2013 they will be able to increase production by 58,000 cases at Chamisal and 50,000 at Seghesio. This leads to total production of 404,000. Assuming revenue per case of $195 and a slower than historical ramp in gross margins to 55%, this leads to net income of nearly $17 million. Net income is equal to EBIT because they have no debt and NOLs shield them from cash taxes. Cash flow will generally be better than net income as maintenance capex is half of D&A.

I estimate that Crimson will earn 70 cents in EPS in 2013 and roughly 79 cents in free cash flow per share. There are two pure play wine companies, Treasury Wine and Concho y Toro. They trade at an average of 20 times 2013 earnings estimates and 14.5 times FCF. Based on these valuations CWGL would be worth $14 on an EPS basis and $12.25 on an FCF basis (once one adds back $22.3 million in net cash). That works out to an average of $13.13, not far from my $13.34 estimate of tangible book value. It is important to remember that CWGL is under earning because its capacity utilization is low.

Conclusion

Crimson Wine Group has all the ingredients of a successful spin-off. The company has savvy management with a large ownership interest, the stock is too small for institutions to hold and there is no sell side following. From the current price of $7.78 the stock has roughly 70% upside to a conservative valuation.

The author is long shares of CWGL. Under no circumstances does this constitute investment advice. Under no circumstances does this information represent a recommendation to buy, sell or hold any security. The information is for educational purposes only. Positions may change at any time without notice.

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